Los Angeles Real Estate Acquisitions

Doron F. Eghbali Real Estate Law What Do Mortgages Encompass in Los Angeles Real Estate Transactions?Purchasing real estate, residential or commercial, most often requires large sums of money. While potential purchasers might borrow from family and friends to consummate the transaction, financial institutions such as banks, loan associations and credit unions are the common sources of such financing. Let us explore the mechanics and some intricacies of mortgages and further enlighten ourselves about them.

Promissory note is rather a formal IOU by which the borrower promises to pay the money back to the lender according to certain terms including payment of the interest for using the money and compliance with the time schedule for making payments on the loan, among other things.

B. MORTGAGE

Mortgage is just another document which secures the debt or provides collateral for the loan if the borrower defaults on it. In fact, if the borrower defaults on the loan or breaches the terms of the mortgage agreement can foreclose on the secured property.

SOME OTHER IMPORTANT YET RELATIVELY BASIC TERMINOLOGY AND OBSERVATIONS

Mortgage Not Always On Purchased Real Estate: This is noteworthy, mortgages are not always made on the purchased real estate. It is conceivable, and feasible for borrower, for instance, to purchase a vacation home but borrows against the already-purchased residence. In such scenario, if the borrower defaults, lender would generally have recourse against the residence, unless their agreement provides otherwise.

First Mortgage OR Second Mortgage, Senior Mortgage OR Junior Mortgage: This ranking order establishes the priority (right) over proceeds of a sale. In fact, mortgages of a lower priority (second and third) are referred to as junior mortgages and mortgages of higher priority are called Senior Mortgages. Hence, if borrower has three mortgages, the second mortgage is Senior to the third mortgage and Junior to the first mortgage. Consequently, the lender having the first priority MAY use all proceeds from sale of real estate (foreclosure sale) if possible and necessary to satisfy the amount owed. Then, if any sales proceeds remain after satisfying the first mortgage, the money MAY be used to satisfy the second mortgage holder, and so on. Any proceeds remaining after satisfying all notes secured by the mortgages belong to the property owner, if any.

Due-On-Sale Clauses: Due-on-sale clauses require the entire note be paid before seller can deed the property to a new purchaser. Nonetheless, some lenders MIGHT allow the new purchaser to ASSUME the loan and make payments on it. In such scenario, the new purchaser becomes wholly liable on the note. Generally, if the underlying property cannot be sold great enough to extinguish the secured indebtedness, then the lender might have RECOURSE to the subsequent purchaser’s other assets for the deficiency. In addition, the first purchaser, generally, remains liable to the lender for any unpaid amounts.

Despite the fact most shopping centers use a standardized uniform lease for most tenants, numerous aspects of such uniform leases should be analyzed and negotiated, to the extent possible, depending upon the financial strength of the parties and prevailing financial conditions. Parties could negotiate as to whether the rent is fixed or it is based on a percentage of gross sales or both, as to whether tenant pays for common areas maintenance costs and how much the tenant is to pay, as to whether tenant is to pay for alterations or improvements and how much, as to whether tenant can sublet or assign part or all of leasehold interests in the premises. Let us, in some detail, analyze SOME of such shopping center lease provisions.

A. SALIENT NOTE

As indicated, most shopping center leases are rather standardized. Such standardized uniformity facilitates renting to prospective tenants without changing the lease for each tenant and enables tenants, to some extent, to accept some terms if they know such terms and provisions are binding upon other tenants, as well.

Consequently, usually, large anchor tenants are successful in negotiating the entire commercial lease. Nonetheless, depending upon prevailing financial conditions, even “small” tenants are often successful in eliciting favorable concessions from shopping center.

B. TERM OF LEASE

Often, shopping center leases are for a fixed term of years. The question rather arises as to when the lease commences, is it when the tenant and landlord sign the lease? Is it when the tenant is obligated to open for business? Is it when the business actually opens for business?

Accordingly, it is incumbent upon the parties to preclude problems by memorializing the commencement AND termination dates of the lease. It is noteworthy, if the shopping center is new the landlord longs to have all rented spaces open for the Grand Opening. On the other hand, the tenant might have signed the lease relatively close to the Grand Opening and logistically might not be able to finish required improvements and alterations in time.

C. FIXED RENT/PERCENTAGE RENT OR COMBINATION OF BOTH

The rent could be fixed annually and payable in equal monthly installments on the first day of each month.

The rent could also be based on the percentage of the gross sales of the business after the sales exceed a base dollar amount. If the rent is paid based on percentage, then the following should be carefully analyzed and considered, among other things:

1. SALIENCE OF UNEQUIVOCAL DEFINITION OF SUBSTANTIAL TERMS: It is imperative for lease to CLEARLY and UNEQUIVOCALLY define “Gross Sales” or any other term employed as a yardstick to ascertain rent percentage. Any ambiguity in such material terms is a breeding ground for litigation.

2. SALIENCE OF TENANT MAINTAINING ACCURATE BOOKS ON PREMISES: In addition, it is imperative for the lease to require tenant to keep accurate books and accounting on the premises to ascertain the necessary numbers required for percentage rent AND to provide landlord with periodic accounting statements.

3. SALIENCE OF LANDLORD’S RIGHT TO CONDUCT AN AUDIT: Furthermore, it is imperative for the lease to provide landlord reasonable access to tenant’s books and for the landlord to conduct an audit of the tenant’s “Gross Sales”.

4. SALIENCE OF LANDLORD’S REMEDIES FOR DISCREPANCIES:Undoubtedly, the lease should provide for remedies in the event the landlord ascertains after an audit the tenant has not been forthright in their transactions and there are deficiencies and discrepancies between what tenant purported to have generated and what the tenant really generated in “Gross Sales”. In addition, it is helpful the lease contains a provision which provides landlord the to terminate the lease if the discrepancy is “substantial” or repeated more than once.

D. SHARE OF COMMON AREA MAINTENANCE COSTS

It is common for shopping center leases to require tenant to contribute to the landlord’s cost of maintaining common areas. Often, tenant is required to contribute based on tenant’s lease of floor area vis-a-vis the total leasable floor area available.

It is imperative for tenant to negotiate and exclude from such calculation the area leased by major tenants such as department stores, before the tenant’s leasable area is calculated for purposes of contributing to common area maintenance costs. The reasoning for such negotiation is a major tenant, as indicated, usually negotiates its own lease and often elicits favorable concessions from landlord. For instance, to induce a major tenant to lease, a landlord might substantially reduce the major tenant’s share of contribution to common area maintenance costs.

If the lease is silent on whether the tenant has an obligation to continuously operate the business, generally, there is no implied covenant to the contrary. Absent such operating covenant, landlord will have difficulty obligating the tenant to operate the business continuously. There is an exception under this general rule if rent under commercial lease is a SPECIFIED BUT UNSUBSTANTIAL MINIMUM PLUS a percentage.

F. ALTERATIONS AND IMPROVEMENTS

If the commercial lease is silent on permitting or requiring alterations or leases, tenant may not make MATERIAL alterations or improvements without landlord’s consent. In such instance, even when landlord consents, such alteration or improvement becomes property of landlord. On the other hand, landlord may desire to have a provision to require the tenant to remove such improvements or alterations upon termination of the lease AND repair damage caused as a result of such removal.

G. ASSIGNMENT AND SUBLETTING

Absent a provision to the contrary, tenant has unrestricted right of transfer. Nonetheless, most commercial leases contain provisions which require tenant to obtain landlord’s consent before assigning the tenant’s interest or subletting the premises. Such leases might also restrict landlord from unreasonably withholding such consent.

Alternatively, landlord may insert a provision to require tenant to pay any profit from assignment or sublease. “Profits” in such context means any amount the tenant receives from sublease or assignment over the rent tenant is paying to the landlord.

SALIENT CAVEAT

This article NEITHER supplants NOR supplements the breadth or depth of such esoteric topic. In fact, this article ONLY provides a rather rudimentary synopsis of such expansive esoteric subject matter.

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